July 29, 2016 - 2:56 PM EDT
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Fitch Rates San Antonio, TX Limited Tax Bonds 'AAA'; Outlook Stable

Fitch Ratings has assigned a 'AAA' to the following San Antonio, TX obligations:

--$211.9 million general improvement and refunding bonds, series 2016;

--$98.4 million combination tax and revenue certificates of obligation, series 2016;

--$24.9 million combination tax and revenue certificates of obligation, taxable series 2016;

--$29.2 million tax notes, series 2016

In addition, Fitch has affirmed the following ratings:

--San Antonio's Issuer Default Rating (IDR) at 'AAA';

--$1.49 billion limited tax bonds at 'AAA';

--$550.4 million public facilities corporation (PFC) lease revenue bonds at 'AA+';

--$31.3 million municipal facilities corporation (MFC) lease revenue bonds at 'AA+';

--$20.9 million Starbright Industrial Development Corporation (Starbright Project) contract revenue refunding bonds, taxable series 2013 at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The limited tax bonds are supported by the taxing power of the city, limited to $2.50 per $100 assessed valuation (AV) for operations and debt service. The PFC and MPC lease revenue bonds are payable from annual appropriations by the city. The contract revenue bonds are special obligations of the Starbright Industrial Development Corporation (IDC) and are payable from pledged contract payments from the city comprised of payments from its electric and gas utility (City Public Service).

KEY RATING DRIVERS

The 'AAA' IDR and GO rating reflect the city's strong revenue flexibility and growth prospects, minimal revenue volatility, and superior financial resilience. These metrics offset the more moderate assessment of the city's expenditure framework that's driven by rapidly rising public safety spending.

Economic Resource Base

San Antonio is the second largest city in the state and seventh largest in the U.S. Prominent sectors include: military and government, domestic and international trade, convention and tourism, medical and healthcare, and telecommunications. Employment gains remain steady despite the contraction of the energy sector that services the nearby Eagle Ford Shale. Steady population growth is fueled by affordable housing prices and ample developable land.

Revenue Framework: 'aaa' factor assessment

The diverse basket comprised of utility revenues, property taxes, and sales taxes that support the city are expected to yield continued solid and steady gains due to rapid population growth. The city's independent legal ability to raise property tax revenues provides ample flexibility.

Expenditure Framework: 'aa' factor assessment

The city's solid expenditure flexibility is derived from management's prudent budgeting practices and moderate carrying costs, balanced against rapidly growing public safety spending driven by costly benefits. The city has demonstrated a solid ability to cut spending during times of economic and revenue decline.

Long-Term Liability Burden: 'aa' factor assessment

Addressing the city's sizeable deferred capital needs may cause an increase in the liability burden but Fitch expects it to remain manageable. The city's unfunded pension liability is moderate and consistent funding of pensions at actuarially determined levels should keep it at this level.

Operating Performance: 'aaa' factor assessment

The combination of the city's expenditure cutting flexibility, revenue raising authority, and minimal revenue volatility leaves it well positioned to address cyclical downturns. The city has demonstrated a commitment to prudent fiscal practices.

RATING SENSITIVITIES

Shift in Fundamentals: The IDR and bond ratings are sensitive to materials change in the city's strong revenue and expenditure flexibility and operating performance, which Fitch expects the city to maintain throughout economic cycles.

CREDIT PROFILE

The local economy continues to expand rapidly with continued sector development in high technology, medical and healthcare, higher education, and financial services, providing diversity beyond the military, which remains a major economic factor. Lackland Air Force Base, Randolph Air Force Base, and Fort Sam Houston account for over 90,000 military and civilian personnel. These facilities benefited from very large investments and additions to troop strength in past base realignments. They also include high-value missions such as the sole medical school for all military medical personnel.

Corporations that are headquartered within the city include: United Services Automobile Association (17,000 employees), Valero (IDR rated 'BBB'), and Rackspace. The expansive employment base remains resilient in the face of low oil prices and stalled exploration activity within the nearby Eagle Ford Shale. The city's unemployment rate declined modestly to a low 3.2% in May 2016 from 3.4% a year prior, aided by a 2.9% gain in employment.

Revenue Framework

The city relies on a combination of utility revenues (31% of general fund revenues), property taxes (27%), and sales taxes (25%). Utility revenues are primarily from City Public Service (CPS; senior lien bonds rated 'AA+') plus a modest amount from San Antonio Water System (SAWS; senior lien bonds rated 'AA+'). CPS revenues have trended upward but are subject to some volatility due to swings in weather and natural gas prices. The relative stability of AV during downturns has provided steady property tax revenues. Sales tax revenues perform in line with the overall economy. Overall general fund revenues have exhibited minimal volatility.

Historical revenue growth has been above the level of inflation and U.S. GDP growth. The city's revenues are projected to continue this trend given the rapidly expanding employment base and strong demographic trends. The city's AV increased by strong 13.5% in fiscal 2016 due primarily to reappraisal gains. A 6.6% gain in median home values over the last 12 months will likely lead to additional AV growth in the near term.

Ample taxing margin remains under the $2.50 per $100 AV property tax cap for operations and debt service.

Utility revenue raising flexibility is limited as CPS payments are capped at 14% of CPS' gross revenues per city ordinance and CPS' master indenture. City council does, however, approve rate increases. Under the flow of funds for CPS utility revenue bonds, distribution of the 14% of gross revenues is the fifth priority, preceded by operations and maintenance expenses, payment of parity bonds and reserves, payment of inferior lien obligations and a distribution to the repair and replacement account.

Expenditure Framework

Public safety is the city's primary responsibility (66% of general fund spending). It is the city's goal to cap public safety spending at this level in order to avoid the crowd-out of other services.

The pace of spending growth absent policy actions is likely to be moderate but pressured by a growing population and costly public safety health insurance benefits. Public safety spending is exceeding general revenue growth.

The city's fixed cost burden is moderate, with carrying costs for debt, pensions and OPEB equaling 18.5% of governmental expenditures.

The framework for collective bargaining agreements (CBA) in Texas gives management control over police/fire hiring and firing and staffing patterns but requires that pay hikes and benefit levels be determined via CBAs. The CBAs for police/fire expired in Sept. 2014, causing both groups to operate under an evergreen clause whereby the terms of the expired agreement (excluding pay hikes) are automatically renewed through Sep. 2024.

Talks with the police and fire associations stalled as the city attempted to realign the costly benefits for police/fire employees and their dependents. Subsequently, the city filed a lawsuit claiming the expired CBA's 10-year evergreen clause is unconstitutional due to its long term. The city lost at the local level but it has appealed to the district court of appeals. No wage hikes are awarded during the evergreen period but all else remains the same including health benefits. The lack of wage hikes in fiscal years 2015 & 2016 nearly offset the cost of the contested health insurance benefits.

More recently, the Texas 4th Court of Appeals granted the city's request to mediate the lawsuit for police, leading to a tentative five-year CBA that includes employee contributions for healthcare, a reduction in the evergreen clause to eight years from 10 years, and a 17% pay increase from fiscal years 2017 - 2021. Additionally, health premiums are to escalate during evergreen periods. The mediated settlement agreement is pending approval from the police association and the city council which is expected in September 2016. Fitch believes the tentative agreement enhances spending flexibility but does note that it lacks a provision for annual reopeners in the event economic conditions decline. The evergreen lawsuit against the fire fighters remains before the courts.

Long-Term Liability Burden

The long-term liability burden, including overall debt and unfunded pension liabilities, is moderate at 17.3% of personal income. Given the city's goal to maintain a flat debt service tax rate, Fitch expects the liability burden to remain moderate as the city addresses its large deferred capital needs with measured debt issuances. With the current offering, the city has exhausted its bond authorization and plans to seek voter approval for $850 million of GO bonds in 2017.

Civilian and certain public safety employees participate in an agent multiple employer defined benefit pension plan administered by the Texas Municipal Retirement System (TMRS). Fire fighters and police participate in a single-employer defined benefit pension plan.

Annual pension payments consistently meet the actuarially required contribution.

Operating Performance

The city's financial resilience is derived from a combination of revenue and expenditure flexibility and minimal revenue volatility. These credit strengths are expected to keep the issuer's reserve levels well above the 'aaa' financial resilience assessment during an economic downturn.

The fiscal 2015 audit posted a $24.9 million operating surplus, increasing its unrestricted fund balance to $235.9 million or 22.8% of spending. Management projects balanced results for fiscal 2016 based on mid-year performance of revenues and expenditures.

In the wake of the last downturn, the city gradually increased its formal fund balance policy from 9% to 10% of spending and increased its two-year budget reserve from 3% to 5% of spending. The fiscal 2016 budget is balanced, reduced the O&M rate by 0.75?, and is based on conservative utility revenue and sales tax growth of 2% and 4.5%, respectively, over fiscal 2015 budget levels.

Appropriation Debt

The payment of debt service on the PFC and MFC lease revenue bonds and the Starbright IDC contract revenue bonds requires an annual appropriation by the city. The contract revenue bonds, unlike other appropriation debt, is payable solely from CPS' payments to the city's general fund. Fitch is not concerned with the sufficiency of pledged revenues to cover contract revenue bond debt service as coverage is very high.

Pursuant to an economic development contract between the city and the IDC, the city is unconditionally obligated to pay debt service on the contract revenue bonds. The payments are not subject to reduction, and the corporation covenants it will maintain the contract in full force as long as bonds are outstanding. Although no additional leveraging is planned, Fitch notes that additional bonds are allowed under the indenture.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009735

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009735

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Jose Acosta
Senior Director
+1-512-215-3726
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Leslie Cook
Associate Director
+1-512-215-3740
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
[email protected]


Source: Business Wire (July 29, 2016 - 2:56 PM EDT)

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